Avoid These 3 Cheap Stocks, Because They Won't Recover

Gap, Zynga and CF Industries continue to face big challenges and are unlikely to show much improvement soon.
By Siddhi Bajaj ,

Editors' pick: Originally published July 8. 

Stocks of a number of underperforming companies have suffered even more following last month's Brexit. In some eyes, this has made them look like steals. But many of these companies are value traps. The underlying reasons that they underperformed are still there.

Consider Gap (GPS) - Get Report , Zynga (ZNGA) - Get Report and CF Industries Holdings (CF) - Get Report . Various issues have hurt these stocks. Zynga suffered a huge selloff in 2012 and has been trading at low levels ever since, while Gap and CF Industries saw their shares decline in 2015. The odds for recoveries aren't favorable. Investors should steer clear of these names, and we'll explain why in greater detail below. 

We also pinpoint a time-tested method for making big profits in good and bad economic conditions.

1. Gap

Gap has been hurting for a while. The San Francisco-based company's decline has stemmed from increasing competition from online retailers and fashion designers who can reach consumers directly via the Internet. Gap, which built a reputation for affordable, quality clothing, can no longer beat many competitors' prices. Meanwhile, the company has also received hefty criticism for the quality of its products. 

Amazon, H&M, Zara are among the publicly traded companies that have replaced Gap in the hearts of consumers. Also, discount retailers such as TJX are finding favor among shoppers who are choosing value over brands.

According to its most recent quarterly results, same-store sales, or comps, dropped 5% and total revenue fell 6%.

Gap's margins have also been shrinking. Gross margins slipped to 36.2% in 2015 from 39.4% in 2013. Operating margins declined from 13.3% in 2013 to 9.6% in fiscal 2015.

A byproduct of the sagging performance: Over the last two years, the stock has lost more than half its value.

To be sure, the dividend yield is a juicy 4.3%. The sustainability of this dividend is in question, however, considering the bleak retail scenario and the company's reduced earnings per share.

Britain's decision to exit the European Union was further bad news for Gap. Of the 183 Gap and Banana Republic stores, 137 are in the U.K. There is no clarity of renewed trade terms after Brexit is complete, putting at least 5% of corporate net sales from Europe in question. There are better ways to invest your money.

2. Zynga

Zynga shares have yet to approach their highs of 2012 that came in the wake of the company's initial public offering. The video game developer, which is well known for its child-friendly Farmville titles, has struggled to keep pace with competitors, a point that CEO Frank Gibeau recently hinted at.

The company has been trying to stage a comeback by launching 10 new mobile game releases this year. Mobile gaming has been a rising trend. 

The stock is off its February lows of less than $2, but it's questionable whether it can sustain this bounceback. To be sure, the once-formidable gaming giant has managed to cut costs and improve revenue generated for every dollar spent on operating activities. However, the company can only continue to generate revenues if it attracts new users and retains old and new ones.

On a year-over-year basis, Zynga users have fallen by double digits. The 13 analysts comprising the Thomson Reuters consensus are offering a 12-month median price target of $2.6. That suggests a bearish decline of 8.8%

There are better values out there.

3. CF Industries Holdings

There is an alarming trend taking place at CF Industries, a leading name in the production and distribution of nitrogen fertilizers and other nitrogen products.

The company continues to ramp up production of nitrogen, although there is a global glut of the product. The consequence: Lower selling prices pulled down profits 89% in the first quarter of 2016 on a year-over-year basis. The stock's price has declined about 60% in the past year, too.

Meanwhile, CF has new manufacturing facilities under construction, which will pressure sales and margins.

Also, the company took a hit after it had to terminate its merger with Netherlands-based fertilizers and industrial chemicals producer OCI due to the U.S. government's new tax inversion rules.

Analysts aren't hopeful about the earnings future of CF, which has missed estimates for the past three quarters. Over the next half decade, CF is expected to generate earnings of a mere 2.7% annually, far underperforming the industry's expected 13% and even the S&P 500's 7.4%.

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This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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